Activity expected to slow in 2017

In 2017, despite a resurgence of growth in the first quarter driven by exports and investment, activity is expected to slow. The economy is strongly export-oriented and will remain constrained by sluggish world demand and the economic slowdown in China - the Middle Kingdom receiving a quarter of South Korean exports. Private debt remains high (253% of GDP) and will continue to dampen activity. Youth unemployment (9.6% in May, compared to 3.6% for the total population) and underemployment, which has been rising since 2014, are sources of concern. In spite of the remedial measures announced by the government, the economy will still be negatively affected by the weakness of SMEs (specifically their lack of competitiveness) and the aging population. Furthermore, it will continue to be a two-speed economy, with dynamic industrial conglomerates - thechaebols –but with a low productivity services sector. The transparency of thechaebols, characterised by family control and hereditary succession, remains limited.

Nonetheless, household consumption is expected to rebound in response to stimulus measures introduced by the former Park’s government, such as tax incentives on car purchases. It could also benefit from the supplementary budget that the new president Moon Jae-in wants to implement, if it is passed. Investment is also expected to benefit from the stimulus plans aimed at supporting activity, in particular house building, but it will be impacted by the restructuring announced in June 2016 in the shipbuilding and shipping sectors (20% reduction in capacity by 2018). Concerned about weak domestic demand, the Bank of Korea has maintained accommodative stance, and kept its policy rate unchanged at 1.25% since summer 2016.

Low budgetary and external risk, but heavy household debt

The stimulus packages allocated to national priorities (increasing the economically active population, stimulating the economy and strengthening security) have not adversely affected the public finances. The growth in expenditure is offset by tax increases such as that on cigarettes. Moreover, the government intends to widen the tax base by taxing the informal sector, which is estimated to be equal to a quarter of the formal economy. As a result, the budget surplus is expected to continue to grow. The public debt will remain sustainable and below the levels observed in most other OECD countries. Nonetheless, contingent liabilities and debt of public-sector companies represent 10% and 30% of GDP respectively.

The current account surplus is expected to dip somewhat, but will remain broadly in surplus in 2017. The value of oil imports is expected to rise in response to the increase in the price per barrel. Exports, which represent 50% of GDP, have been rising since October 2016, benefitting from strong activity in developed markets, but they are expected to be hit by the drop in Chinese demand.

In this context, the level of foreign exchange reserves will remain satisfactory. However, the won still depends on capital flows and could depreciate against the dollar with the tightening of US monetary policy. Nonetheless, the strength of the current account surplus and the weak correlation between the Korean bond market and global risk aversion should help limit movements in the currency. Finally, the high level of household debt, which reached a new record ($1170 billion in the last quarter of 2016, an 11.7% jump from the previous year), is a risk for the banking sector.

Moon Jae-in elected president

After the impeachment of Park Geun-hye, whose trial for corruption and abuse of power has begun on May 23rd 2017, Moon Jae-in (Minjoo Party of Korea) was elected president on May 9th. During the campaign trail, he promised a relatively soft line on North Korea, and he made economic pledges to drive growth. On June 7th, his government proposed a supplementary budget to the National Assembly, which represents 0.7% of GDP, financed by the fiscal surplus, aimed at creating more than 100.000 jobs, in particular in the public sector, and fostering entrepreneurship, However, as the president’s Party has only 40% seats, this supplementary budget may not pass, the opposition arguing that it does not meet the requirements of the National Finance Act (war, natural disaster or danger or mass unemployment).

The new president expressed his will to strengthen the alliance with the United States, even if he suspended at the beginning of June the THAAD's deployment (antiballistic missile system). Moreover, Moon Jae-in wants to improve relations with China, which should lower geopolitical uncertainty in the region, and favour risk-on modes and portfolio inflows into Korean asset classes. Eventually, the president advocates dialogue with North Korea under the “sunshine policy”, to develop economic exchanges, but the risks persist. North Korea conducted dozens of ballistic missile tests and two nuclear tests since 2016. Since then, its rhetoric has been very aggressive. Repeated threats made by North Korea illustrate the instability of relations between the two economies. The UN adopted new sanctions on June 2nd 2017, against 14 north-Korean officials and 4 entities.